III. ECONOMIC TRENDS AND OUTLOOK Economic Overview South Africa is the most advanced and productive economy in Africa. Initially based on gold and diamond mining, the economy diversified over the last 50 years and is now broadly based. South Africa is a middle-income developing country with a gross domestic product (GDP) of $111.8 billion (1993) and a population of over 40 million. Manufacturing represents the largest sector of the economy, contributing 26 percent of GDP, followed by finance and business services (16 percent), commerce (13 percent), mining (11 percent), and agriculture (6 percent). South Africa is rich in mineral resources including gold, coal, iron ore, chrome, manganese, diamonds and platinum group metals. In fact, the only major mineral products not found in South Africa are petroleum and bauxite. A diverse climate permits cultivation of a wide variety of crops, but inadequate and erratic rainfall means that only about 15 percent of land is arable. The farming sector recently recovered from a severe drought. South Africa's diversified manufacturing industry is a world leader in several specialized sectors, including railway rolling stock, synthetic fuels, and mining equipment and machinery. Principal manufacturing activities include steel and other basic metals; heavy engineering; transport, electrical and automative equipment; food processing; industrial and agricultural chemicals; pulp and paper; and textiles and clothing. Major Trends and Outlook South Africa's prolonged recession of more than four years bottomed out in 1993, when the economy recovered somewhat to register 1.1 percent growth. Two principal factors, including a substantial increase (six percent) in the volume of merchandise and net gold exports and a significant recovery in agricultural production contributed to this revival in economic activity. Although the agriculture sector accounted for most of the growth during the early part of 1993, the increase in economic activity spread to other sectors in the second half resulting in growth in the mining, manufacturing, electricity, gas and water, and commerce and finance areas. Nevertheless, the South African economy faces a number of longer term problems such as a shortage of skilled labor, inefficient trade policies (trade reforms proposed at the GATT Uruguay Round could reverse this practice over time), concentration of economic power within conglomerates and high taxes. Past apartheid policies have caused illiteracy, unemployment, and other social problems among South Africa's black majority. Slow growth in real non-farm production and rapid population growth have caused real per capita GDP to decline for six years in a row. South Africa's restrictive monetary policy and the lingering effects of the recession have succeeded in reducing consumer inflation to its lowest level since 1973. After dropping to 13.9 percent in 1992, inflation declined to 9.7 percent in 1993 as drought-induced food price increases slowed, consumer demand diminished and wage increases moderated slightly. Both the real and nominal exchange rate of the commercial rand weakened during the year, to trade at R3.2667 to the strengthening U.S. dollar. On the other hand, despite heavy battering from investor uncertainty, the financial rand appreciated during the year to trade at R4.296 to the U.S. dollar, a discount of roughly 30 percent to the commercial rand. South Africa's balance of payments situation further weakened in 1993. Major capital outflows and a decline from last year's record surplus on the current account resulted in a fall of R2.3 billion in net foreign reserves for the year, compared to increases of R2.9 billion and R1.4 billion in 1991 and 1992. At year end 1993, the total gross gold and foreign reserves amounted to R11.2 billion, equivalent to only about six weeks of import cover. GDP in 1994 is expected to increase 2.5 to 3.5 percent, with year- end inflation around 8 percent. The commercial rand is expected to depreciate to an average R3.67 to the US dollar for 1994, and the surplus on the current account surplus will likely reach R6.8 billion. Several factors could alter these forecasts, however, including the economic policies of a newly elected government, a constrained balance of payments, future commodity prices, and the growth of global economy. South Africa could be in a position to experience an economic boom over the next few years thanks to the global economic upturn, agricultural recovery, export growth and private and public sector investment in infrastructure. These positive developments could in turn generate additional employment, higher disposable income and sustained economic growth. Nevertheless, progress in these areas may be dependent on how the next dispensation unfolds and the economic policies it decides to follow. Principal Growth Sectors South Africa is the largest export market for U.S. goods and services in sub-Saharan Africa. U.S. exports to South Africa totaled $2.4 billion in 1993, almost double the level in 1990 and representing roughly 14 percent of South Africa's total imports. South Africa's $20 billion import market should expand as its economy emerges from four years of recession and as local business confidence stabilizes in the election aftermath. The United States' 14 percent import market share has strong potential to increase as the new government commences an ambitious socio- economic rebuilding program, local business confidence improves, remaining state and local sanctions are lifted, and as American companies continue to enter or return to the South African market. Increased local business confidence should translate into increased spending on imports, especially to boost low or nonexistent inventories, support export expansion into other African markets, and to replace old technologies. Much of South Africa's industrial plant capacity is aged and needs to be upgraded. The one drawback to significant market expansion is South Africa's outmoded protective trade regime which uses high tariffs to combat competitive imports. Nevertheless, South Africans have very high regard for American technologies, and American brands labels enjoy tremendous recognition amongst South African consumers. The new South African government's reconstruction and development program will translate into sales opportunities for American companies in the areas of housing, telecommunications, electrification, healthcare, water, sewage, and education. Although South Africa's sophisticated local business community is capable of providing for much of this demand, it is questionable whether it has the capacity to meet the extreme needs that exist; especially given the tremendous political imperative to address the socio-economic legacies of poverty as early as possible. (For example, the Minister of Housing's ambitious plan is to build 350,000 new homes per year.) American companies can make important contributions to this process by providing appropriate, cost- effective technologies. Other sectors expected to grow rapidly include telecommunications, particularly cellular services, electricity generation, defense industry exports, and electronics. In addition, an important part of South Africa's economic expansion will be minerals and primary products beneficiation for export markets. Increased beneficiation will create significant opportunities for American sales of capital equipment, and technologies such as industrial process controls. Mining: Despite some diversification of the economy away from mining, South Africa's mining and quarrying industry remains a key and essential element of the economy. Mining and mining input industries together constitute one third of GDP. Mining accounts for about half of foreign exchange earnings, employs about 12 percent of the workforce directly and possibly one-third indirectly, is an important market for domestic suppliers, and is a raw materials source for local mineral-based industries. In 1993, South African production of most major minerals increased slightly. However, due largely to a higher gold price, total mineral export revenue dramatically increased by 26 per cent. Despite the increase in production, the size of the labor force continued its long term decline. Since 1989, the industry has shed over 150,000 employees. In the face of continuing declines in employment, real wages are falling. Gold production, which accounts for about half of the value of mineral production and 62 percent of mineral exports, increased only slightly in 1993 to 616 tons. However, because the price of gold increased substantially, especially in rand terms, the value of gold production grew by 22 percent. Although South Africa remains the world's largest gold producer, its high inflation rate and difficult mining conditions have resulted in the industry becoming, on average, a high-cost producer. In order to remain competitive the industry will need to continue its stringent cost containment programs. The outlook for 1994 is moderately optimistic. Overall growth in the major industrial economies is projected to be higher than in 1993. This economic recovery should increase the demand for and prices of industrial metals resulting in a growth in South African export revenue. Longer term trends include increasing the value of mineral exports through further processing and the diversification of the economy away from mining. Agriculture: 1993 was a much better agricultural year than 1992. The drought broke and the volume of agricultural production increased by 11.8 percent compared to 1992. The volume of field crops produced increased by 51.3 percent compared to a decrease of 40.3 percent in the previous year while horticultural and livestock production did not show major changes. During 1993 producer prices increased by only one percent compared to 18.8 percent in 1992. As a result, the value of agricultural production increased by 17.5 percent to R26.9 billion of 1992. The gross income of producers increased by 16.3 percent to R25.1 billion during 1993 mainly due again to the increase in income from field crops. The net farm income amounted to R7.3 billion, which was 43.2 percent higher than in the previous year. Interest payments remained a major cost item due to the high level of farming debt amounting to 10.4 percent of gross income. As the prices of farming inputs increased by 9.4 percent over the year expenditure on intermediate goods and services increased by 11.4 percent to R10.4 billion. The contribution of agriculture to the gross domestic product at factor cost for 1993 increased by 21.7 percent to R14.8 billion representing four percent of the total GDP for 1993. Agricultural prospects for 1994 are even better with the sharp increase in grain production. For example, corn production is expected to increase from about 10 million tons in 1993 to about 14 million tons and exports to increase to about 5.5 million tons compared to 1.5 million tons from the previous crop. Unfortunately the prices for the crop have still not been decided. The agricultural policies of the new Government regarding commercial agricultural production and marketing are not yet clear but will apparently be based on the free market. Major discussions on tariff levels for previously controlled products are being held with the new, more consumer oriented government, agricultural producers and other interested parties. Increased trade is expected but no numerical data would be reliable because of the extensive changes taking place and to take place in the marketing system. Government Role in the Economy Relatively open one by world standards, the South African economy achieved diversification through policies of import substitution, protection of infant industries through high tariffs, and the establishment of parastatal industries. As a response to international economic sanctions to protest apartheid, government economic policies from the mid-1970's became increasingly autarkic and protectionist, and the state invested heavily in industries such as armaments and synthetic fuels. In recent years, government officials have conceded that past policies contributed to the structural problems that have hampered South Africa's economic performance in the last decade. In response, the government has moved to reduce its role in the economy and to promote private sector investment and competition. It has lowered tax rates and begun a policy of trade liberalization. The government is pursuing a policy of privatization of some parastatal corporations and directed others to operate on a commercial basis. The central bank is following strict monetary policies to lower inflation. The transition to a democratic, majority government, begun in February 1990, stimulated a debate on future economic policies to achieve sustained economic growth and redress the socio-economic disparities of apartheid. Government officials and business persons, on one hand, and leaders of the extraparliamentary opposition and trade unions, on the other, are now generally agreed that a majority government will pursue market based policies with the private sector as generator of wealth and the government actively addressing the inequities in health, education, housing and social services. The government exercised considerable financial restraint in 1993 and for the second consecutive year real government consumption expenditure increased by less than .5 percent compared with an average annual rate of 4 percent in the 1980s. The public deficit as a ratio of GDP accordingly declined from 8.6 percent in 1992 to 6.8 percent in 1993. Higher increases in revenues than in expenditures accounted for the improved deficit figures. (During the first nine months of the year, revenues increased by 15.5 percent over 1992's figures while expenditures increased by 9.4 percent over the same period). Nevertheless, a public deficit of this level is still unsustainable and if maintained could result in extremely high levels of government debt. Moreover, it still remains double the global norm of 3 percent of GDP and above the 6 percent level to which the South African government committed itself as a condition of borrowing from the IMF. Given these conditions, the public deficit situation could be a potential constraint facing a new government. Balance of Payments Situation South Africa's balance of payments situation weakened in 1993, primarily the result of R16.3 billion in capital outflows for the year. The surplus on the current account of the balance of payments increased its 1992 level of R3.9 billion to R5.9 billion due to a substantial rise in the value of merchandise and net gold exports. The value of total merchandise exports rose 14.5 percent, while merchandise imports gained about 13.5 percent in value. The current account surplus is vital to South Africa's debt repayment scheme under arrangements made with foreign creditors following a freeze in 1985 on new foreign capital inflows. Negotiations were successfully completed on a final rescheduling of South Africa's USD five billion worth of standstill debt during the latter half of 1993. The debt, to be paid over a period of eight years, would be completely amortized by August 15, 2001. The IMF drought facility of USD 850 million would be used to help meet the initial payment due in February 1994. Total net capital outflows for 1993 reached R16.3 billion, compared to R6.5 billion in 1992. Deterioration on the capital account resulted in a further decline of R10.3 billion in South Africa's net foreign reserves for the year. At the end of December 1993, the total gross gold and foreign reserves amounted to R11.1 billion, thanks to drawings on foreign credit facilities, resulting in a marginal decline from 1992's level of R11.2 billion. Nevertheless, South Africa's foreign reserves are only roughly equivalent to about five to six weeks' worth of import cover. South Africa operates a two-tier foreign exchange system, the commercial rand and the financial rand, with the latter reserved for investment and capital exports of non-residents. The commercial rand depreciated again during 1993 to R3.2667 to the U.S. dollar owing to large capital outflows, long-term inflation differentials with the country's main trading partners and political uncertainty. (The real effective exchange rate of the rand also declined by 4.9 percent). On the other hand, despite heavy battering by violence, political uncertainty and overseas investment by South African corporations in 1992, the finrand appreciated in value over 1993 to 4.2953 lowering the discount between the two currencies close to 30 percent. Trade and Investment Barriers Major Trade Barriers: There are few major trade barriers. Traders are subject to exchange control approval, administered by the South African Reserve Bank. This is only a formality. The Ministry of Trade and Industry is empowered to regulate, prohibit or ration imports to South Africa in the national interest and most goods may be imported into South Africa without restrictions. Import permits are required for various categories of goods and are obtainable from the Director of Import and Export. Surcharges at rates between 7.5 percent and 40 percent are levied on the import of selected products. Importers must possess an import permit prior to the date of shipment. Failure to produce a permit could result in the imposition of penalties. In recent years the list of restricted goods requiring import permits has been reduced. The South African Government and banking system recognizes the need to turn the country from an isolated import substitution regime to a competitive, export focused market economy. Progress towards the goal of changing the focus of the economy from import substitution to exports requires improving the competitiveness of the heavily protected industrial structure. Reducing tariffs, eliminating import surcharges, and a realistic exchange rate would be steps in the right direction. In anticipation of the lifting of sanctions, companies from around the world have been introducing their products to South African distributors and end-users. As a result, many South African firms must adapt to genuine competition for the first time in years. To survive and to develop markets abroad, South African firms must institute quality and cost controls, practice aggressive marketing techniques, and become customer and service oriented. Many will become more competitive, but some that are not economically viable without protectionist measures will not survive. For products where price is the major factor, the steady devaluation of the rand will ensure that even inefficient industries continue to operate. Major Investment Barriers: The Government of South Africa encourages foreign investment and treats it essentially the same as domestic enterprise, with only a few areas of economic activity reserved for domestic ownership. Foreign investors face differences regarding access to domestic financing, and local borrowing restrictions imposed by exchange control authorities, but have access to the two-tiered foreign exchange system. Using the Financial Rand is very advantageous for importing capital, as profits and dividends are remitted in Commercial Rand. Foreign investors can use the Financial Rand to purchase fixed assets, e.g. machinery, property, etc., and the Commercial Rand to remit income to non-residents, including dividends, interest and royalties. Companies that are 25 percent or more owned or controlled by non- residents face limits on local borrowing. The primary purpose of these restrictions is to ensure the adequate capitalization of foreign investments and to prevent excessive gearing, i.e. a company borrowing against its share capital. The definition of local borrowing includes overdrafts, financial leasing of capital equipment, mortgage bonds and local shareholders' loans in excess of foreign shareholders' loans. The largest potential disincentive to increased foreign investment would be an anti-business policy direction which inter alia levied high tax levies to support the Reconstruction and Development Program. The 1994 budget carefully avoided this, and there is no evidence that would be the case in the future. The now government has shown no interest in employing nationalization as a policy tool in spite of ANC statements about that in years past. Substantial domestic markets with significant growth potential, a good infrastructure, access to other markets in Africa, liberal repatriation of profits, inexpensive power and abundant raw materials are attractive inducements which appeal to foreign investors. Although returns are fairly high, the risk factors of violence and political uncertainty are of most concern to foreign investors. However, in the past two years, several American firms have invested or reinvested in the "new" South Africa. A few U.S. State and local sanctions still hinder American trade and investment in South Africa. These sanctions could include procurement bans, selective contracting and purchasing statutes, and mandatory divestment by pension funds, and they have varying conditions regarding termination. Once ANC President Mandela called for a lifting of remaining world economic sanctions in September 1993, the process of repealing them moved forward very quickly. A status report on state and local sanctions can be obtained from the South African Embassy in Washington, D.C. or from the U.S. Department of State Bureau of Southern African Affairs at telephone (202) 647-8434. Labor Force See discussion in Section VII. Major Local & Third Country Competitors in Specific Sectors Top Ten Exporters to South Africa by Country in 1992 *(Millions of Rand) 1. Germany 8588.0 2. USA 7141.9 3. Japan 5562.9 4. United Kingdom 5380.9 5. France 2052.5 6. Italy 1842.9 7. Taiwan 1766.8 8. Netherlands 1248.2 9. Switzerland 1222.9 10. Belgium 1138.1 Top Ten Importers from South Africa by Country in 1992. (Millions of Rand) 1. Switzerland 5382.2 2. USA 4857.6 3. United Kingdom 4524.7 4. Japan 3761.3 5. Germany 3007.8 6. Taiwan 2148.8 7. Belgium 1998.1 8. Netherlands 1928.2 9. Italy 1656.4 10. Zimbabwe 1553.4 Top Exporters to South Africa by country and by sector Mineral Products (Millions of Rand) 1. USA 158.8 2. Zimbabwe 79.7 3. China 66.8 4. United Kingdom 30.7 5. Germany 29.4 6. Canada 28.3 7. Togo 21.3 8. Poland 17.5 9. Japan 16.1 10. France 15.7 Total 464.3 Chemical Products (Millions of Rand) 1. Germany 1115.6 2. United Kingdom 1000.4 3. USA 822.9 4. Switzerland 449.6 5. Netherlands 371.9 6. France 333.3 7. Belgium 323.3 8. Japan 247.9 Total 4664.9 Wood and Wood Products (Millions of Rand) 1. Malaysia 79.5 2. USA 66.4 3. Singapore 56.8 4. Zimbabwe 51.8 5. Portugal 32.8 6. France 20.0 7. Brazil 12.5 8. Canada 10.8 Total 330.6 Wood pulp, paper and articles (Millions of Rand) 1. United Kingdom 351.5 2. USA 331.8 3. Germany 234.5 4. Finland 96.5 5. France 61.1 6. Canada 59.5 7. Japan 48.8 Total 1183.8 Textiles and Textile Articles (Millions of Rand) 1. Taiwan 321.5 2. Germany 252.5 3. South Korea 223.8 4. United Kingdom 166.2 5. China 161.5 6. Zimbabwe 139.3 7. Hong Kong 134.8 8. USA 115.4 9. Japan 106.1 10. Italy 102.5 Total 1723.6 Base Metals and Articles (Millions of Rand) 1. Germany 497.1 2. Japan 318.4 3. United Kingdom 299.3 4. USA 240.4 5. Taiwan 124.1 6. Italy 117.4 7. France 117.1 8. Zimbabwe 96.7 9. Australia 75.3 10. Belgium 71.3 Total 2022.8 Machinery and Electrical (Millions of Rand) Equipment 1. Germany 3317.3 2. USA 2375.2 3. United Kingdom 1800.5 4. Japan 1724.3 5. Italy 818.3 6. Taiwan 816.3 7. France 723.4 8. Switzerland 408.6 9. Netherlands 400.9 10. Hong Kong 338.2 Total 12723.0 Vehicles and Equipment (Millions of Rand) 1. Japan 2470.7 2. Germany 1906.3 3. USA 852.9 4. United Kingdom 467.2 5. France 299.3 6. Italy 187.3 Total 6183.7 *Exchange Rate in 1992 - R2.8516 = USD 1 Infrastructure South Africa's ports, railway, road and air transportation infrastructure are well-developed and support both the domestic market and the southern African region. South Africa has a well- developed transportation infrastructure that supports an efficient distribution of imported goods to major urban centers. The road, rail, and air transport service is excellent throughout most parts of the country. The quality of infrastructure in the rural areas and former homelands varies, however, and most nonwhite "townships" are in need of road development and improvement. The telecommunications and electrical infrastructure provide first-world standard service in urban areas. The availability of water supply to support mining and industrial development, particularly in the greater Johannesburg area, is nearing the limit of its capacity. A bilateral water development scheme with Lesotho will provide additional supplies in the next decade, but water supply will remain a development constraint. South Africa's transportation infrastructure is largely controlled and operated by the government-owned Transnet. Transnet's five transport divisions include Spoornet (rails), Portnet (ports), Autonet (roads), Petronet (pipelines), and South African Airways, all of which operate as separate companies. Several private sector companies provide trucking services, and recently a number of private airlines have begun to provide competitive service to the government-owned South Africa Airways.